Option Investor

Daily Newsletter, Saturday, 10/1/2011

Table of Contents

  1. Market Wrap
  2. Index Wrap
  3. New Option Plays
  4. In Play Updates and Reviews

Market Wrap

September to Remember

by Jim Brown

Click here to email Jim Brown

The good news, September is over. The bad news Q3 was the worst quarter for the markets since the Great Recession. Bad Q3s are normally followed by strong Q4s.

Market Statistics

It was an ugly quarter with a -14.3% decline in the S&P but it could have been worse. The S&P hit a high of 1356 on July 7th and a low of 1101 on August 9th. That was an 18.8% drop. Even though September will be remembered for some extreme volatility it was significantly better than the beginning of the quarter.

September is normally the worst month of the year for the markets and October, even though it is known for new lows, it is also known as the "bear killer" month because many bear periods in the market have ended in October and many times with dramatic rebounds. Obviously nobody knows if that will happen this year but we are definitely coming to a crisis point in Europe that could either tank the global markets for the rest of the year or provide the relief rally that produces a strong Q4.

Economic reports on Friday actually provided a slight glimmer of hope but it was very slight. The ISM Chicago, formerly PMI, rose to 60.4 in September from 56.5 in August. Analysts were expecting a small decline. The new orders component rebounded strongly to 65.3 from 56.9, an increase of nearly 10 points. Employment also rose to 60.6 from 52.1 and the first time over 60 since May. The production component rose to 63.9 from 57.8. The only material decline came in the backorders, which declined to 45.4 from 49.6. The gap between new orders and back orders at 19.9 is the widest gap on record. The average is 7.1 points.

The ISM Chicago is influenced by the automakers. As automobile production increases it generates thousands of orders for supplies and components. Even though this report is influenced by autos it is still a positive report and any business improvement is welcomed.

Chicago ISM Chart

The ISM New York for September was 538.0 and a minor gain over August at 537.6 but still a gain. August was the first decline in two years so any rebound is encouraging. The current conditions component rose to 50.6 from 47.8 but the current conditions component declined to 55.9 from 59.9. The quantity of purchase component rose sharply to 54.8 from 47.1 and the first positive number since May. A number under 50 represents contraction.

The New York area suffered from Hurricane Irene and from the Verizon strike that put 45,000 people out of work. The heavy security presence surrounding 9/11 probably depressed activity as well. Policemen with machine guns on every corner tend to keep a lot of people off the streets. I expect this report to rebound sharply next month.

Consumer sentiment for September rose unexpectedly by +3.7 points to 59.4 when most analysts were expecting a decline due to the drop in stocks. Falling stock prices normally depress sentiment but then the August reading of 55.7 was the lowest since November 2008 so it was already low. That reading was the result of the debt ceiling debacle and the S&P downgrade of the U.S. credit rating. I guess a few hundred points on the Dow was not as negative as those events. The survey declined -8.7 points in the first two weeks of August and has been rising slowly ever since.

Consumer Sentiment Chart

We hear constantly in the news about better than expected or worse than expected economic reports. Many times you can have both on the same day. I went back and recapped the material reports for the entire month of September so you can see visually how the month transpired. Those highlighted in yellow were worse than the prior month and those in green were better than the prior month. The reports covering August were worse than July 16 times and better only 5 times. Those covering September were better 8 times and only two were worse than August. You can't really develop a definitive analysis until this time next month when we can measure like periods.

However, there is nothing in these reports that suggests we are entering a recession today. The mixture of positive and negative reports is appropriate for a stagnant economy not a recessionary economy.

September Reports

However, the ECRI Weekly Leading Index declined for the seventh time in the last eight weeks and the annualized growth rate declined to -7.2%. This is a very long term index that takes into account data from many of those reports in the graphic above. The WLI does not move in big increments but is more of a directional index than a sudden wakeup call that something just happened. The WLI is reaching levels we saw back in 2010 when everyone was afraid of a double dip recession. If the index moves below that 2010 low it would generate a fear trade as institutions begin moving to cash on recession fears.

The ECRI titled their report U.S. Economy Tipping into Recession.

ECRI WLI (Moody's Chart)

The economic calendar for next week is crowded but there are only a handful of critical reports. The ISM on Monday will be key however the improvement in several of the regional reports suggests the ISM will remain above the 50 level and in expansion territory. Analysts are expecting it to be close so any upside surprise would be positive. Likewise a dip much below 50 would be seriously market negative. However, it takes a number in the low 40s to indicate a recession.

The Nonfarm payroll report on Friday is expected to show an increase of 60,000 jobs compared to the zero from last month. I expect that zero reading to be adjusted downward to show a loss of jobs in August. It never has the same impact when prior months are adjusted lower so there is always the question on whether the officials are adjusting to remain positive in the initial report and then correcting their adjustments once it is old news. The consensus range for September is from a loss of -10,000 jobs to a gain of 90,000 so plenty of disagreement among analysts.

The ADP Employment report on Wednesday will be a market mover as it tries to predict the nonfarm numbers due out on Friday. The ADP report has a lousy record of performance on forecasting the numbers but it is still gets a lot of attention when it is released.

We have seen numerous regional reports recently that have shown improvements in the employment components. The weekly jobless claims last week fell to 391,000 and the lowest level since April 2nd. On the surface that should indicate the jobs number will be positive although probably only by a small amount. However, many analysts reported there was a potential problem with the seasonal adjustment for last week and the headline number may not be correct. That is why the forecast for this week is much higher at 411,000 and back in line with the recent trend.

Economic Calendar

Europe received another shot of the hope drug last week when Germany and Austria voted to approve the EFSF at 440 billion euros. The German market promptly lost another -2.5% after the vote was announced. That means Germany's portion of the EFSF liability rose to 211 billion euros from 123 billion. That works out to tax bill of 4,000 euros for everyone in Germany if the loans defaulted. Since the eventual end of this story is a Greek default it would appear Germany just voted for a large tax increase for its citizens.

These sugar highs from the various positive events out of Europe are going to continue to wear off faster and require more stimulus to rekindle the closer we get to Greece flipping everybody off and restarting the printing presses to print drachmas.

With that said there is always the hope that someone in the European high command will decide to grow a backbone and force something to happen before Greece gets to that point. Europe could fix this problem but it would be expensive and that is why they continue to take baby steps towards the cliff because they know it is going to hurt a lot when it finally happens.

Along with Germany's vote was a firm stand against any further "enhancement" of the EFSF. Since the 440 billion version is not going to be enough that firm stand may be the beginning of the end. It may take another year to play out but the eventual end is known.

The 440 billion problem everyone is voting on today, no longer exists. When the EFSF was first created and then expanded it might have been enough to solve the problem. Unfortunately the problem has grown over the last six months from billions to trillions as the situation deteriorated in Italy and Spain. Everyone continues to warn about a domino decline once Greece defaults but instead of dealing with it now they continue to kick the can down the road in hopes of a miracle solution.

Did you know that Italy, Spain and Portugal are guarantors of the EFSF bailout funds just like Germany and France. Since Italy, Spain and Portugal need bailouts of their own from the fund, just how is that going to work? They can't afford to put any money in despite their signatures to the agreement. Portugal guaranteed part of the EFSF bond to Ireland but Portugal is just as bad off as Ireland. Two later EFSF bond issuances were to bailout Portugal. That means in the case of default the countries with money like Germany and France will be forced to come up with even more. Lastly the EFSF is not prefunded. When the money is needed the EFSF will have to come up with investors willing to part with billions of euros to invest in a vehicle with an ever expanding mandate that lends money to banks and governments that the markets have decided are insolvent. Greece is a prime example. How easy will it be for the EFSF to continue raising money to fund Greece when everyone knows at any time they may only be days away from a default?

The only sure event in Europe's future is that quite a few people are going to lose a lot of money. In the event of a default banks all over Europe are going to be wiped out. Everybody that owns a piece of the 357 billion euros that Greece owes is going to be hurt badly with a 50-90% loss. Stockholders in the banks and institutions holding the debt will be wiped out. As a condition to recapitalization by the EFSF those stockholders will be erased. It is not going to be pretty.

The calendar for next week includes the meeting on Monday of the 17 euro zone (EZ) finance ministers. You can bet Greece will be at the top of the agenda. The troika will be in Greece going over their progress on the bailout conditions. The EZ leaders will decide on the 13th on whether Greece gets the next tranche of eight billion euros. On the 17th Greece will run out of money if they don't get the payment. They said they would print IOUs to bridge the gap but basically they are bankrupt. If the payment is made it will be just another dose of currency crack and Greece will be right back knocking on the drug dealers door very soon looking for another dose.

You can't cure too much debt with more debt. Nobody has ever been able to survive for long by getting a cash advance on one credit card in order to pay their other credit cards. Eventually you run up so much debt that no lender will extend your credit line and you implode. That is Greece today. They are borrowing money from their lender of last resort and their credit line with the EFSF will eventually be exhausted. The only way they will ever be able to pay back their debts is when the face value of that debt is slashed dramatically.

Denmark announced an expanded $72.8 billion liquidity increase for its banks. Danish bank failures have made it more difficult for the remaining banks to access credit. Denmark said it would expand the collateral it accepts for loans and they would offer six month loans in addition to the normal seven day loans. The credit crisis continues in all forms.

In stock news for Friday it was one of those days when nothing was working and there were some ominous signs of distress. With the Q3 earnings cycle kicking off in just over a week there were several earnings disappointments. Darden Restaurants (DRI) and Nucor (NUE) both warned earlier in the week. Darden said customers ordered fewer appetizers, drinks and deserts at its various restaurant chains. They said customers in general were being more frugal with their spending.

On Friday Ingersoll Rand (IR), a maker of climate control systems and residential security systems, warned that consumer related sales were "significantly affected" in the third quarter. Commercial security sales were also slower than expected. Ingersoll now predicts earnings of 77-80 cents for Q3 compared to 85-95 cents previously forecasted. Full year earnings are now expected to be $2.70-$2.80 and reduced from $2.90-$3.10 per share. IR missed estimates of 93-cents in Q2 with earnings of 88-cents. IR had reaffirmed its profit guidance on August 8th. The stock was crushed on the news.

United Technologies (UTX) also warned in July the air conditioner market was soft. UTX makes Carrier air conditioners.

Ingersoll Rand

Micron (MU) lost ground after posting a loss of 14-cents per share compared to analyst estimates for a profit of 2-cents. Micron said weak demand for personal computers was the cause. That pushed prices lower for DRAM chips. Revenue fell -14% to $2.14 billion. Micron is the only remaining U.S. based maker of DRAM chips with all others made in Asia. DRAM prices fell -15% for the quarter. Micron also warned the jury was out in its legal dispute with Rambus. A negative verdict would have a material impact on Q4 earnings. Micron shares fell -14% on the news.

Micron Chart

Eastman Kodak (EK) may be going the way of the Polaroid camera and 8-track tape. The stock fell -54% on Friday after news broke they had hired Jones Day, a law firm known for bankruptcy cases. Kodak sold the first consumer camera in 1888. The company denied it was going to file bankruptcy and said it was looking for a way to monetize its patents of which it has thousands worth an estimated $2 billion. The company had already hired Lazard to advise on strategic options on its patents. With its market value at roughly $210 million on Friday it would appear to be an easy target for a hostile takeover just to get the patents. Kodak was worth $31 billion in 1997.

Kodak shares had already declined on Monday after it said it drew down its $160 million credit line. The stock hit a 38-year low on Monday and exceeded that on Friday. Several analysts theorized that a bankruptcy and then a sale of the patents would maximize the value of the patents for the benefit of creditors. Prospective buyers today would be worried about potential suits if Kodak sold its most valuable assets while owing millions of dollars to creditors. Shareholder suits would also be suppressed in a bankruptcy. Shareholders are already hostile to management because of the share price decline.

Kodak invented one of the earliest digital cameras but shelved the project because it did not want to risk damaging its lucrative film business at the time. Oops!

Kodak Chart

The agricultural sector was hit by a plague of locusts on Friday after the USDA released data showing that corn stockpiles were 150 million bushels larger than previously expected. Corn futures imploded and the fertilizer companies were crushed. The sector has been a roller coaster this year with alternating floods and droughts checker boarding the country and making yield projections a dart throw. Corn futures declined -6.3% to limit down at $5.92 per bushel.

Corn Futures

Fertilizer companies were hit pretty hard with POT falling -5%, CF -12% and MOS -10%. Mosaic was already heading lower after reporting disappointing earnings earlier in the week. The company also said that margins would continue to be tight due to rising costs for ammonia and sulfur. Mosaic missed earnings estimates despite significant improvement over the same period in 2010. Earnings for the quarter were $1.17 compared to 67-cents in 2010. Analysts were looking for $1.29.

The drop in share price caused the planned secondary offering to be cancelled. The Cargill family trust selling the 21.3 million shares said it was unwilling to sell its shares at the current prices. Mosaic was going to buy the shares to increase the available shares in the market in conjunction with being added to the S&P-500. The Cargill trust owns the shares as a result of the initial Mosaic spinoff. The shares were priced at $57.65 the previous Friday with a planned closing of the offering on Thursday. With MOS shares at $49 on Friday I doubt that offering will be rescheduled soon.

Mosaic Chart

Starbucks (SBUX) CEO Howard Schultz said despite months of economic turmoil sales at Starbucks were strong. "Starbucks is having its best year and our business remains strong." He was asked if his customers were responding the same way as the Darden customers and he said absolutely not. He saw no signs of summer weakness. That failed to help the stock with SBUX falling nearly $4 since the Wednesday high.

Starbucks Chart

Morgan Stanley shares fell -10% on Friday on growing worries over its exposure to Europe. Morgan Stanley has claimed in recent weeks that it has zero net exposure to Greece but analysts fear it might have indirect exposure through banks in Europe. On their annual 10-K for the end of 2010 Morgan Stanley said it had cross border exposure of roughly $96 billion with France accounting for about $39 billion of that amount. That is 60% more than Morgan Stanley's market capitalization Based on their most recent filing the exposure to France has declined to $29.3 billion.

Morgan Stanley Chart

Alibaba Chairman, Jack Ma, said he was very interested in buying Yahoo. Ma said late Friday he has had discussions with Yahoo as well as some other potential buyers. Alibaba is 40% owned by Yahoo so Ma has a valid reason for buying Yahoo if only to reacquire that 40% stake. He said there were quite a few people interested in Yahoo but he would not disclose any names. Shares of Yahoo rose +5% when the news broke after the close on Friday. Yahoo executives said earlier in the week they have answered inquiries from "multiple parties" interested in "unspecified options."

The Yahoo spokesman said they were pursuing many strategies including seeking a new CEO after Carol Bartz was fired in August. The process for reviewing strategic options is likely to take "months, not weeks," according to a memo signed by co-founders Jerry Yang and David Filo and Chairman Roy Bostock. Jack Ma and Jerry Yang are reported to be close friends but after Alibaba split off Alipay without Yang's knowledge you have to wonder if those rumors are true.

Reportedly private equity firm Silver Lake is considering a bid for Yahoo and would sell off the Asian assets (Yahoo Japan and Alibaba) and then focus on the core Yahoo business. Silver Lake has approached other parties to gauge interest in purchasing Yahoo's main business.

Yahoo Chart

The U.S. Dept of Energy completed $4.75 billion in loan guarantees for four solar projects on Friday. That was the deadline for the 2005 program funded by the stimulus act. The projects were being developed by ProLogis, SunPower and First Solar. Many had expected the Solyndra scandal to halt or delay the loan guarantees due to the revised paperwork required after the scandal broke. There were some projects that failed to receive guarantees because of the short timeframe to complete the new post-Solyndra documentation. Over the life of the program it has provided guarantees for more than $11.4 billion covering 25 solar, wind and geothermal projects. Solyndra was $535 million of that total.

Copper declined -26% for the month to close at $3.11 and a new 52-week low after the HSBC PMI for China for September came in at 49.9 and in contraction territory for the third consecutive month. The preliminary reading had been 49.4. The HSBC survey covers more than 400 companies and is weighted towards small businesses that have been hit harder by the tightening monetary policy. China was quick to claim the underperformance was due to the months of tighter monetary policy and the lag effect of rate changes.

China's official PMI, prepared by the China Federation of Logistics and Purchasing came in at 51.2 and 0.1 point ahead of a Bloomberg survey of 13 economists for a reading of 51.1. This was the highest reading in four months and a small +0.3 gain over the 50.9 in August. The survey of more than 820 companies in 20 industries has not fallen below 50 since February 2009. China is still expected to grow at 8.5% to 9.0% in the coming years and that is well over the rest of the world.

However, China's credit default swaps (CDS) have been rising. Manufacturers are rumored to be struggling to make payments for supplies and analysts are becoming increasingly worried these may be the early signs of China's bubble bursting. The worries over China have caused declines in oil, copper, steel, coal and other commodities even though there has been no real decline in orders.

Copper is normally seen as a predictor of global growth. Copper is used in so many products that demand has been a reliable predictor of economic activity. That does not prevent dips and spikes on rumors but the longer trend is usually correct. The trend for September was counter to the current expectations for growth and that has produced numerous rumors of hedge funds in trouble and liquidating futures positions. While there are probably many hedge funds in trouble I believe the selloff in copper, gold, oil, etc is related more to raising cash rather than a sudden fear about a China crash. The CME raised margin rates the prior Friday and that accelerated the decline.

Copper Chart

The worries out of China plus the rising recession worries in Europe and the USA helped to push oil prices below support at $80 at the close. Prices held above $80.50 until just after 2:PM and then the bottom fell out producing a $3.39 loss.

U.S. WTI Crude Chart

U.S. WTI Crude Chart - 5 min

The sharp drop at the close in futures and equities suggests it was not stock or sector specific but institutions closing the books on the quarter by going to cash wherever possible. When the market is plunging towards new lows many fund managers want to show more cash and fewer positions on the end of quarter statements. In a rising market managers will buy more stocks at the end of a quarter in what we call window dressing to put the best spin on their portfolios.

In quarters where stocks are declining they do the opposite with a "window washing" cycle where they slim down positions and eliminate others to produce the most conservative picture possible for bear market viewing by shareholders.

The market was really bad in Q3. That should be no surprise to anyone reading this newsletter. The equity markets had the worst quarter since the Great Recession. So where did the money go? Investors and institutions moved money out of equities and into bonds. When the debt ceiling debacle was coming to a close just before August 1st the flood of money into bonds rose to a tsunami. Bond yields on the major instruments declined 40-45% for the quarter. That is about a 10 point move on the Richter scale for bond investors.

Ten-year Note Yield Chart

How bad was Q3? It was the worst quarter since the Great Recession. The only real gains were limited to bonds, gold and the dollar. All of those turned into flight to quality assets but even gold gave back much of its gains as the quarter came to a close. Cash was the only asset that did not depreciate and that depends on your point of view.

Quarter Statistics

The S&P close at 1131 was fitting for the worst quarter in three years. The only spot that would have been better would have been a close at critical support at 1120. It would appear likely that we are going to see new lows. The market sentiment has been growing increasingly bearish and without a bullish stampede at the open on Monday I expect that 1120 support to be tested and possibly broken next week.

However, and there always has to be a however, if last week was a window washing event we could easily see money put back to work in those same beaten down sectors that were crushed so badly last week. Any new money coming into the market from retirement contributions is going to be looking for the most oversold sectors to minimize downside risk.

Since the Greece bailout payment may not be resolved for two weeks there will be plenty of negative news to weigh on the markets. If managers are looking for one more big crash before putting money back to work they may wait until after the Greek payment to avoid unnecessary risk. The lack of purchases while waiting on Greece could allow us to test those lower levels.

In the best case scenario Greece would be awarded the money, the can kicked down the road until December and a relief rally would be born. If that scenario comes to pass then the next market hurdle would be the super committee in Washington and their $1.5 trillion in new budget cuts due around Thanksgiving. If they don't come up with the cuts another $1.2 trillion will automatically go into effect and those cuts are far less desirable. This suggests there will be another deadline disaster with political brinksmanship. Let's just hope it is far enough down the road that a post Greece rebound can gain some traction.

All that assumes the Nonfarm Payroll report is not double ugly and knocks the market for a loop next Friday. Event risk is still our number one problem.

S&P-500 Chart - Daily

S&P-500 Chart - Weekly

The Dow closed on the low for the Day but still managed to gain +141 for the week. I suspect that was a fluke and only because time expired on Friday. Once 11,000 broke the decline was fairly rapid. I don't recall seeing this many Dow components with a loss of more than a dollar in a long time. IBM was the big loser with a -4.30 drop and accounting for more than -35 Dow points.

If the selling continues on Monday the odds of a retest of 10,600 are very good. I am so tired of this negative and choppy market I almost wish we could get an event to push the Dow to 10,000 and end the pain. That is a long way off and I think it would be an excellent buying opportunity. I don't think 10,600 is going to hold unless we have a sudden burst of good news.

Dow Chart - 30 Min

Dow Chart - 90 Min

Dow Chart - Daily

The Nasdaq closed at the low for the day and the low for the month at 2415 and a loss of -65 points. It has been under heavy pressure since 2:PM on Tuesday when the markets all rolled over in unison. The selling across all markets was coordinated but techs and small caps were the hardest hit. Considering tech stocks are normally strong performers in Q4 you would have thought bargain hunters would have some buy orders pending.

The drop below support at 2430 appears to be targeting 2340. Even Apple was sold hard with a -$9 drop to $381 and a three week low. Amazon has been falling since the tablet announcement on Wednesday saw the stock rally to more than $235. Analysts believe they will take a loss on every Kindle Fire sold in hopes of gaining market share and encouraging buying in the Amazon marketplace from Kindle Fire users. Others believe this is a winning strategy because it does not compete directly with the iPad and improves the shopability of the Amazon market. They will definitely sell more products to anyone with a Kindle Fire. The decline is a normal sell the news event but it did help push the Nasdaq lower.

Google also closed right at a four week low at $514 with a $12 loss. Everyone producing an Android tablet will now have to compete with the Kindle Fire on price and that means margins are going to get squeezed.

The pressure continued on Chinese stocks after the SEC said it was investigating accounting irregularities. The Chinese stocks have been decimated over the last week and that included U.S. stocks with a presence in China. Wynn Resorts (WYNN), with a major investment in Macau has declined -$25 in the last two days since the news broke.

Priceline (PCLN) was hit for -$31 on Friday and is down -$90 over the last seven days.

Priceline Chart

If the market opens negative on Monday I think we will eventually see that retest of 2340. Sentiment has turned seriously negative and recent earnings surprises from companies like Micron suggest the semiconductor sector is going to lead techs lower.

Nasdaq Chart - 90 Min

Nasdaq Chart - Weekly

The Russell 2000 small caps are in bear market territory with a decline of more than 22%. The Russell closed very near a new 52-week low on Friday with a break of support at 650. If the 640 level fails next week we could see a retest of 590. That should be very strong support and I would definitely be a buyer at that level. It would be an opportunity most fund managers would not be able to pass up. A break below 590 is inconceivable at this time without some additional deterioration in Europe, economics and earnings.

That comment will probably come back to haunt me but that is the way I see it today. Conditions can always change. However, sentiment is already seriously negative. We have a higher probability of a positive change from positive earnings and a temporary resolution in Europe than conditions continuing to worsen and become even more bearish.

Russell 2000 Chart - 90 Min

Russell 2000 Chart - Weekly

The Dow Transports have decent support at 4050 but that support could weaken if earnings guidance deteriorates. Freight shipment guidance is very mixed with some carriers claiming business is good and others saying it has fallen off over the last 60 days. We will have a better picture once they begin reporting earnings and guidance.

Best Buy reported it was only going to hire half as many seasonal workers this year because sales were not expected to be strong and inventory would be lower. Multiple manufacturers and analysts have reported lower orders for this holiday shopping cycle. It will be interesting to see if shoppers perform as expected or clamor for more products. The auto sector is booming and that would seem to suggest consumers are not that bearish about future prospects.

Smaller holiday inventory orders would require less shipping but higher volumes of new cars and trucks as well as oil and coal could make up a lot of that volume.

Dow Transport Chart - 90 Min

Sam Stovall, chief equity strategist at S&P, pointed out that whenever there is a sharp decline of more than 10% in a quarter it is normally followed by a 7.2% gain in the next quarter. When the decline happens in Q3 the chances for a strong rebound are even greater. He said investors are like hyper active first graders playing musical chairs. Every investor is trying to "out anticipate" the other on when to jump back into the market. The -14.3% decline in the S&P removed about $1.7 trillion in capitalization from the market.

Stocks are also relatively cheap today. The S&P-500 is trading at a PE of only 10.7 times what analysts think companies will make in 2012. That is historically cheap compared to the 10-year average of 15 and 17-18 in bull markets. In February it was trading at 13.6 times. Q3 earnings expectations have come down from the July 1st level of +17% earnings growth to just over 13% today. The key to that future PE calculation is the assumption that companies are not going to disappoint when they begin reporting or guide lower for Q4 and beyond.

My outlook for next week is negative but there is always the possibility of an opening bounce for the new quarter. New retirement contributions will be flooding in and managers have plenty to choose from in the way of distressed assets for long term investments. There will probably be a strong short squeeze in our immediate future and how traders react to that squeeze will be key. Eventually one of these squeezes will fail to roll over and the race will be on to higher ground.

Fund managers are seriously negative for the year with some funds down over 30%. They are going to be grabbing at every opportunity to add performance into year-end in order to save customers and their bonuses. I think it is too early to expect that next week but once we get into the first real week of earnings (17th to 21st) any positive surprises could provide fuel for the rise higher.

Jim Brown

Send Jim an email

"I find that the harder I work, the more luck I seem to have."
Thomas Jefferson

Index Wrap

8 Weeks of a Trading Range

by Leigh Stevens

Click here to email Leigh Stevens

Sole focus on how much the Dow was down for the quarter obscures the interesting story for options traders of the well-defined index trading range of the past 2 months. The S&P 500 traded in a hundred point range, the Nasdaq Composite in a 200 point range. Unfortunately, it's nearly impossible to predict the DURATION of a trading range market. Hence the use of exit/stop points.

IF we knew that SPX would trade between 1205-1215 on the upside and 1133-1122 on the downside over two expirations, what a deal in terms of the spread possibilities. Likewise in terms of the Composite trading between 2413-2600; there were 2 weeks of 2630 highs and in the first 3 weeks of 8, COMP lows were in the 2340 area. With the Nas 100 (NDX), the 8-week trading range has been 2300 on the upside (with 1 spurt to 2338) and 2040 on the downside.

I usually trade breakouts up or down but every time I've thought that was happening it was a fake out. So, I've been mostly standing aside trading wise while the Market has been range bound. Not my kind of market conditions but hopefully it's been great for some of you!

Something driving us all crazy now is how to interpret price action over the prior 8 weeks. Has it been basing action for an eventual move higher or a pause before there's a substantial new down leg, such as to 1000 in SPX and to 2200-2100 in the Composite; or, to around 1950 in the Nas 100.

We do see MAJOR double tops in SPX (March-August 2000 and July to November 2007 and in COMP in the Fall 2007 and the cluster of highs (the H&S Top) in Feb-July. There may be major tops in place, but this has little to do with upcoming trading opportunities, except keeping our expectations in check for how much upside potential exists.

I can't predict if the indexes are going to reach the aforementioned major downside support areas, but upside breakouts would be suggested by the indexes crossing above current trendline resistances at 1185 in SPX, 2600 in the Composite (also an area of substantial supply, as well as resistance implied by a return to the weekly Feb-July Head & Shoulder's 'neckline') or to above 2267 in NDX.

Those who would prefer a directional trade could wait for possible upside breakout moves OR buy in major support areas I've identified above. Of course, bottoms could be made shy of the major support areas mentioned. A bullish turnaround may be seen on a key upside reversal, especially if accompanied by heavy volume, an oversold RSI and extreme bearishness in my trader sentiment indicator.

I don't think the current trading range will go on for another 8 weeks, or 6, or past October even. More time in the current range would be nice for paired options positions. A move to well under our past 2-month price range would likely see oversold extremes registering in both the 8-week and 8-month RSI and probably 'set up' a next key bottom and a trading opportunity in calls.

Summing up, I suggest that we're in a wait and see mode here as to the next market turn. Volatility has climbed again in the past week and the numerous price reversals are keeping many if not most investors on the sidelines.



The S&P 500 (SPX) continues bearish in its pattern but a key test of support is near, at 1120-1125, with support (more likely) extending to 1100. Major support begins in the 1050 area, extending to the even 1000 level.

Near resistance is at 1185, at the previously broken up trendline. SPX just about got TO the trendline but without a breakout, which was bearish. Next resistance is seen in the s1220 area.

I look for lower levels and a likely test of 1100, or lower.


The S&P 100 (OEX) chart is in a bearish pattern again as it failed to hold its brief pop above resistance implied by the previously broken up trendline. It looks like the index is headed for a retest of prior lows around 500. Major support looks like it begins in the 470 area and extending to 460-459, or the lows made in July-August 2010.

Resistance is at 530, extending to around 540 to 548.

The chart suggests OEX is headed lower. Maybe 500 will be a key support again. Like the Dow 30, the recent double bottom low was looking promising. If the index goes there again, it may not hold this area again. Triple bottoms in the indexes aren't all that common.


The Dow 30 (INDU) chart is bearish to 'mixed' in the sense that INDU is falling again, maybe to again retest support at 10600, but it's a gradual decline as INDU has slipped, but not dramatically, below its 21-day moving average again.

I thought the chart was looking mildly bullish with the second low setting up again at 10600. The passage of some weeks made this second identical low look more promising than if it had been a week apart. About the most bullish thing I can say is that about half of the Dow 30 stocks are holding in a sideways pattern; the other half are sliding lower just not dramatically so.

11185 is near resistance implied by the current level of the 21-day moving average, with next resistance in the 11335 area; with further overhead resistance in the 11500 area.

Support is highlighted at 10600 as mentioned, with next support estimated for around 10440. Major support begins at 10,000 extending to 9600.


The Nasdaq Composite (COMP) chart is bearish in the near-term as prices broke to a new Closing low for the current move. Somewhat predictably, resistance was hit at the previously broken up trendline; i.e., support or support trendlines, once pierced, tend to 'become' resistance on subsequent rebounds. COMP looks headed still lower.

I've noted initial technical resistance in the 2500 area, then at 2580, extending to 2600, at the current intersection of the trendline.

Near support has to be assumed at the prior lows in the 2330 area, extending to 2300. Major support begins around 2207, extending to 2200.

The 13-day Relative Strength Index (RSI) suggests that the Composite isn't yet at an oversold extreme and would have to sink lower to have this factor favoring those probing for a bottom. Moreover, trader sentiment is just not showing the kind of bearish extreme that would suggest this added aspect of an oversold market. Bullishness is still 'too high' in my opinion to suggest that the seeds of a rally were setting up anytime soon.


The one-day rebound to above resistance in the Nasdaq 100 (NDX) index implied by the previously pierced up trendline was not enough to suggest a decisive upside breakout. As I often say, beware of single-day apparent breakouts or 'breakdowns' that don't see follow through the next day. Sure enough, the next day saw NDX sink below its up trendline again on new bearish news/perceptions.

Key near resistance and the new 'breakout' point is implied by the current intersection of the trendline at 2267, with resistance extending to 2300.

Next support is at 2100, which is also where the lower 5% envelope line intersects. I noted last week that with recent high at the upper 5% line, a decline might carry to the lower 5% envelope. The envelope lines are again providing somewhat of a guide to where NDX is 'extended' either on the upside or the downside. However, if the index is going to overshoot the envelope values (set in relation to the 'centered' 21-day moving average), it is likely to do so on the downside as NDX did before. Below 2100, we're looking at support implied by the double bottom low in the 2037 area.


The Nasdaq 100 tracking stock (QQQ) saw a bearish break of support implied by the low end of its month + uptrend price channel. Key near resistance is implied by this 'broken' trendline at 53.5, with next resistance around 56.

Daily trading volume was again high on the break toward the end of the week. I noted last week that: "Daily trading volume spiked on Thursday sharp decline, suggesting that there are still holders that can get 'flushed' out of their positions if prices break enough. Not exactly a bullish omen." How true is turned out to be.

Anticipated support is first at 52, than in the 50 area. Major support is expected in the 48.5-47.7 price zone. This past week's price action could be the beginning of a next down leg. Stay tuned on this outcome. NDX is not yet 'fully' oversold according to the RSI as can be seen above


The Russell 2000 (RUT) chart is bearish in its pattern as it broke to new lows for the current decline. I wrote last week that: "... if this was a commodities chart, I'd be forecasting another down leg ahead. It just looks so." The 'commoditization' of the stock market seems to be one effect of great uncertainty and also computer programs helping drive that kind of volatility.

It looks like RUT could be headed to a test of support in the 600 area, with potential support extending to around 587. Since RUT has now retraced more than 66% or 2/3rds of its August 2010 to May 2011 advance, retracement theory would suggest that the index could be headed back to a retest of the July-August double bottom low at 587 and a 100% retracement.

681 is key resistance suggested by the down trendline as highlighted on the daily chart; it would take a couple of consecutive Closes above this level to suggest a bullish turnaround. Next resistance then would be in the 718 area, extending to the 738 area.


New Option Plays

Small Caps, Restaurants, and Energy

by James Brown

Click here to email James Brown

Editor's Note:

In addition to tonight's new candidates, the following stocks look like bearish trades right now:


If you're looking for more bearish candidates you may want to consider the following:


If you're looking for a generic bet on the market then consider puts on the DIA or the SPY.

- James


iShares Russell 2000 ETF - IWM - close: 64.30 change: -2.03

Stop Loss: 67.55
Target(s): 60.50, 57.00
Current Option Gain/Loss: + 0.0%
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The stock market looks very, very vulnerable to more selling pressure. The major indices, including the Russell 2000 index, have built multiple bearish technical sell patterns. If the market does breakdown then the small caps should underperform. That's why we're suggesting puts on the IWM.

I am suggesting new bearish positions now. More conservative traders may want to wait for a new relative low under $63.49 before initiating positions. I am listing our targets at $60.50 and $57.00. We do want to keep our position size small. The market remains volatile.

- Suggested Positions - (Small Positions)

buy the OCT $60 PUT (IWM1122V60) current ask $1.78

- or -

buy the NOV $60 put (IWM1119W60) current ask $3.17

Annotated Chart:

Entry on October 03 at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 83.2 million
Listed on October 01, 2011

Panera Bread Co. - PNRA - close: 103.94 change: -3.74

Stop Loss: 108.55
Target(s): 98.00, 92.50
Current Option Gain/Loss: + 0.0%
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Investors are growing concerned that the U.S. consumer is cutting back and spending less. Some of the restaurant stocks are starting to take a hit. You can see on PNRA's daily chart that the oversold bounce was not able to rally past the 61.8% Fibonacci retracement of the sell-off. Now the stock is breaking down from its trading range. Friday's drop and failure near $108 looks like a new entry point to buy puts.

I am suggesting bearish positions now. Conservative traders may want to exit and take profits near $100. I am listing two targets. Our first target is $98.00. Our second target is $92.50. The August low near $97 could be support so don't be surprised to see a bounce.

The Point & Figure chart for PNRA is bearish with am $88 target. FYI: I do need to caution readers that the most recent data listed short interest at about 10% of PNRA's small float of approximately 28 million shares. That's above average short interest and a widespread market bounce could spark some short covering.

- Suggested Positions -

buy the OCT $100 PUT (PNRA1122V100) current ask $3.60

- or -

buy the NOV $95 PUT (PNRA1119W95) current ask $4.60

Annotated Chart:

Entry on October 03 at $ xx.xx
Earnings Date 10/25/11 (unconfirmed)
Average Daily Volume = 574 thousand
Listed on October 01, 2011

Pioneer Natural Res. - PXD - close: 65.77 change: -2.73

Stop Loss: 71.01
Target(s): 60.50, 56.00
Current Option Gain/Loss: +0.0%
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The energy sector is breaking down on worries of a global slow down. Shares of PXD are helping lead the way lower. The stock's recent oversold bounce has failed once it filled the gap and now PXD hit new lows on Friday. I am suggesting we launch small bearish positions now. I caution you to keep positions small to limit our risk since the energy sector can be a little volatile.

I am suggesting new bearish positions right now with a stop loss at $71.01, which is just about 10 cents above Thursday's high. Our first target is $60.50. Our secondary target is $56.00 but that could take a few weeks.

The Point & Figure chart for PXD is bearish with a $51 target.

- Suggested Positions - (Small Positions)

buy the OCT $60 PUT (PXD1122V60) current ask $2.00

- or -

buy the NOV $60 PUT (PXD1119W60) current ask $3.90

Annotated Chart:

Entry on October 03 at $ xx.xx
Earnings Date 11/01/11 (confirmed)
Average Daily Volume = 1.8 million
Listed on October 01, 2011

In Play Updates and Reviews

Sinking Into Quarter End

by James Brown

Click here to email James Brown

Editor's Note:

Money managers felt the need to do some window undressing before the quarter ended on Friday. The U.S. market suffered widespread losses with the major averages down more than -2%. The volatility index (VIX) surged +10% and set its highest close in weeks.

Traders are cautious. We had CELG and WPI both get stopped out. Meanwhile our put plays are naturally performing well in this market.


Current Portfolio:

CALL Play Updates

Check Point Software - CHKP - close: 52.76 change: -0.65

Stop Loss: 50.80
Target(s): 55.75 , 57.75
Current Option Gain/Loss: -27.7%
Time Frame: 3 to 4 weeks
New Positions: see below

10/01 update: CHKP tried to rally on Friday but the stock ran out of steam by lunchtime and reversed lower. The $51.00 level and its exponential 200-dma are both still support for the stock but more conservative traders may want to consider an early exit now! I am not suggesting new positions at this time.

- Suggested Positions -

Long OCT $55 call (CHKP1122J55) Entry $1.80

10/01 readers may want to consider an early exit now.
09/26 trade opened.


Entry on September 26 at $53.00
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on September 20, 2011

Hewlett Packard - HPQ - close: 22.45 change: -1.33

Stop Loss: 21.45
Target(s): 29.50
Current Option Gain/Loss: - 4.2%
Time Frame: 8 to 12 weeks
New Positions: see below

10/01 update: One of the big stories for HPQ on Friday was news that Amazon.com (AMZN) might be interested in buying HPQ's webOS business. Another big story was how much HPQ's fired CEO, Mr. Apotheker, would collect in severance pay (about $7.2 million), but I doubt either really were to blame for HPQ's relative weakness on Friday (-5.5%). Fund managers could have done some last minute dumping to get HPQ off their books before the end of the third quarter given HPQ's -38% slide for the quarter.

HPQ should find support at $22.00 and at $21.50 but these levels may not hold up if the S&P 500 breaks down to new lows with any momentum. I am not suggesting new positions at this time.

- Suggested Positions -

Long 2012 Jan. $24 call (HPQ1221A24) Entry $2.14

09/27 new stop loss @ 21.45


Entry on September 23 at $22.52
Earnings Date 11/21/11 (unconfirmed)
Average Daily Volume = 26.6 million
Listed on September 22, 2011

PUT Play Updates

Caterpillar Inc. - CAT - close: 73.84 change: -1.55

Stop Loss: 77.25
Target(s): 73.50, 70.50
Current Option Gain/Loss: +68.9%
Time Frame: 2 to 3 weeks
New Positions: see below

10/01 update: Traders initially bought the gap down on Friday morning but the intraday rebound ran out of gas. CAT closed near its lows with a -2.0% decline on Friday. Shares are quickly approaching their 2011 lows set a week ago at $72.60. CAT might see an oversold bounce from this level (72.60) but then again both this stock and the market's major indices look poised to breakdown.

We are not suggesting new positions at this time but nimble traders might consider another failed rally near the 10-dma as an entry point. Please note that we're lowering our stop loss to $77.25. Our final target is $70.50. More aggressive traders may want to aim lower (possible the $66-64 zone).

- Suggested Positions -

Long OCT $75 PUT (CAT1122V75) Entry $2.93

10/01 new stop loss @ 77.25
09/29 1st target hit at $73.50. option bid $5.00 (+70.6%)


Entry on September 28 at $78.13
Earnings Date 10/24/11 (unconfirmed)
Average Daily Volume = 11.2 million
Listed on September 27, 2011

Flowserve Corp. - FLS - close: 74.00 change: -4.60

Stop Loss: 78.25
Target(s): take profits now and exit at $70.25
Current Option Gain/Loss: Oct$75: +92.0% & Nov$70: +75.0%
Time Frame: 3 to 6 weeks
New Positions: see below

10/01 update: Exit target update!

Many of the industrial stocks underperformed on Friday. Shares of FLS gave up -5.8% and set a new closing low for the year. I am suggesting we go ahead and take profits now (at the open on Monday). The bid on the October $75 put is $4.80 (+92%) and the bid on the November $70 put is $4.90 (+75.0%).

We'll adjust our final target to $70.25. More aggressive traders could still aim for the $65.00 area. We are not suggesting new positions at this time.

Please note our new stop loss at $78.25.

- Suggested Positions -

Long OCT $75 PUT (FLS1122V75) Entry $2.50

- or -

Long NOV $70 PUT (FLS1119W70) Entry $2.80

10/01 Prepare to take profits ASAP, at the open on Monday
10/01 new stop loss @ 78.25


Entry on September 29 at $80.23
Earnings Date 10/26/11 (unconfirmed)
Average Daily Volume = 721 thousand
Listed on September 28, 2011

Regal-Beloit - RBC - close: 45.38 change: -3.66

Stop Loss: 49.25
Target(s): 43.50, 40.50
Option Gain/Loss: (wide spreads) Oct$45: +75.0% & Nov$45: +17.3%
Time Frame: 3 to 6 weeks
New Positions: see below

10/01 update: An earnings warning from IR rattled the industrial stocks and RBC plunged -7.4% on Friday. Cautious traders may want to think about taking some profits early right now. We are lowering our stop loss to $49.25. I would not launch new positions at this time.

Warning! The option spreads are a little wide. We want to keep our position size small to limit our capital at risk.

- Suggested Positions - (small positions)

Long OCT $45 PUT (RBC1122V45) Entry $1.00

- or -

Long NOV $45 PUT (RBC1119W45) Entry $2.30

10/01 new stop loss @ 49.25


Entry on September 29 at $49.01
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 456 thousand
Listed on September 28, 2011


Celgene Corp. - CELG - close: 61.91 change: -1.02

Stop Loss: 61.75
Target(s): 69.00
Current Option Gain/Loss: -37.9%
Time Frame: 3 to 4 weeks
New Positions: see below

10/01 update: The stock market sold off again on Friday afternoon. Yet for CELG the weakness was Friday morning. Shares spiked down to $61.63, and hit our stop loss at $61.75 along the way. I would keep CELG on your watch list as a bullish candidate if the market turns higher.

- Suggested Positions -

OCT $65 call (CELG1122J65) Entry $1.53, exit $0.95 (-37.9%)

09/30 stopped out at $61.75
09/29 new stop loss @ 61.75
09/27 new stop loss @ 61.25


Entry on September 26 at $63.03
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 4.0 million
Listed on September 22, 2011

Watson Pharmaceuticals - WPI - close: 68.25 change: -2.66

Stop Loss: 69.75
Target(s): 74.75, 78.50
Current Option Gain/Loss: Oct$75: -60.0% & NOV$75: -47.6%
Time Frame: 3 to 6 weeks
New Positions: see below

10/01 update: The late afternoon bounce on Thursday did not last very long. WPI opened weak at $70.10 and quickly hit our stop loss at $69.75 very early Friday morning. Shares eventually settled with a -3.7% loss. I'd keep WPI on your watch list as a bullish candidate should the stock market develop a more bullish posture.

- Suggested Positions -

OCT $75 call (WPI1122J75) Entry $1.00, exit $0.40 (-60.0%)

- or -

NOV $75 call (WPI1119K75) Entry $2.10,exit $1.10 (-47.6%)

09/30 stopped out at $69.75
09/27 new stop loss @ 69.75


Entry on September 26 at $71.26
Earnings Date 11/01/11 (confirmed)
Average Daily Volume = 1.4 million
Listed on September 24, 2011